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Novum Alpha - Daily Analysis 11 March 2021 (10-Minute Read)

China is chomping at the bit! Stocks in the Middle Kingdom had come under pressure earlier when Beijing central bankers warned of bubbles in both U.S. and European markets and warned that leverage was getting out of hand.

Top of the Thursday to you and I hope you're having a terrific one! 

In brief (TL:DR)

  • U.S. stocks were a mixed bag on Wednesday with the S&P 500 (+0.60%) and blue-chip Dow Jones Industrial Average (+1.46%) up on the reflation trade by while the tech stock rally came to an abrupt halt again and the tech-centric Nasdaq Composite (-0.04%) flat.  
  • Asian stocks open mixed as the rotation into value shares resumed in the U.S. Treasury yields were steady after a tame inflation report.
  • The benchmark U.S. 10-year Treasury yield held at 1.52%.
  • The dollar held on to losses. 
  • Oil edged up with April 2021 contracts for WTI Crude Oil (Nymex) (+0.61%) at US$64.83, on optimism over the sharpening pace of economic recovery. 
  • Gold rose slightly with April 2021 contracts for Gold (Comex) (+0.19%) at US$1,725.00 on a sliding dollar and as stimulus and inflation come into focus. 
  • Bitcoin (+0.30%) briefly topped US$57,000 before pulling back to US$55,737 as investors grew their risk appetites. Outflows from exchanges led inflows (outflows suggest that traders are looking to hold Bitcoin in anticipation of higher prices).

In today's issue...

  1. Did You Remember to Vote for your SPAC?
  2. Is the U.S. on the Brink of Another Housing Crisis?
  3. Where Has the Bitcoin Arbitrage Trade Gone?

Market Overview

China is chomping at the bit! 
Stocks in the Middle Kingdom had come under pressure earlier when Beijing central bankers warned of bubbles in both U.S. and European markets and warned that leverage was getting out of hand. 
But the sharp correction in Chinese stocks saw Beijing pullback on those earlier remarks and rally a horde of Chinese brokers in the biggest stock buying program since the Chinese stock market crash in 2015. 
Bullish economic data out of the U.S. and the passing of Biden's US$1.9 trillion fiscal stimulus package has Chinese companies cheering on expectations of a sharp recovery in consumer demand from a captive (literally) U.S. consumer market. 
Asian stocks rallied with China at the open, with Tokyo's Nikkei 225 (+0.25%), Seoul's Kospi Index (+1.84%) and Hong Kong's Hang Seng Index (+0.16%) all higher, while Sydney’s ASX 200 (-0.34%) was flat in the morning trading session. 
1. Did You Remember to Vote for your SPAC?
  • Flood of retail investors pouring into Special Purpose Acquisition Companies is creating unforeseen problems for their arrangers who struggle to get shareholders to vote on acquisitions as more expiries loom 
  • SPAC shareholders may be unaware or uninterested in participating in the vote for a SPAC forcing their promoters to go to internet forums to issue reminders or garner support for acquisitions at risk of returning funds to SPAC investors 
It’s hard enough to get people to vote in local and national elections, even though the monetary impact of that vote is difficult to quantify, it's even harder to get them to vote on things that can be quantified.
Imagine a vote which can be quantified – say 10 bucks is the loss you’d suffer if you didn’t vote – that actually doesn’t make it better, it makes it worse.
But one of the idiosyncrasies of SPAC (Special Purpose Acquisition Company) investments is that voting is crucial to the execution of their business plans.
A SPAC, for the uninitiated, is basically a blank-check company that raises money from investors via a listing on a stock exchange, with the promise to acquire companies that its promoters have the special expertise to identify.
But when a SPAC’s arrangers have found a potential acquisition target, shareholders of the SPAC still need to vote on that acquisition before it can be approved.
The problem? Most SPAC investors don’t care or know enough to vote.
Because SPAC investing tends to draw in the more speculative segments of the retail investing market who don’t have much skin in the game, an increasing number of acquisitions are being derailed as retail investors fail to show up in sufficient numbers for critical shareholder votes on deals.
SPACs generally launch with a price of US$10 a share, and if an investors only has US$10 riding on what is a punt, they aren’t invested enough to care in the success or failure of the SPAC, they just want to make a quick profit off that punt.
And the problem is far from small, with a Bank of America (+2.89%) report released last month revealing that 40% of all trading in SPACs are originated from individual investor accounts, creating an added dimension of risk for SPAC investors.
Because even if the SPAC has found a great company to acquire that could add serious value to the vehicle, that acquisition could fall through because of retail shareholder apathy or ignorance to move the process along.
SPACs are not new, and in the past, large brokerages would vote on acquisitions.
But the rise of retail investors buying SPACs directly through their online trading accounts means that they bypass their typical brokers and now have to actually perform the role of a shareholder.
The other problem is that some SPAC resolutions require a super majority to be approved, including votes on extending time to close acquisitions, which typically require 65% of shareholders to agree.
SPAC investors may want to take note that many of the SPACs that were so hot in 2019, are now nearing “best by” date without so much as a hint of an acquisition – as these SPACs near expiry date, the price for their shares is bound to head southwards unless arrangers can guarantee the votes.
The problem has gotten so bad that SPAC arrangers and backers have had to take to Reddit forums (the Bloomberg terminal for retail investors) to remind SPAC holders that they need to vote.
So if you just bought shares in that hot new SPAC, don’t forget to vote.  
2. Is the U.S. on the Brink of Another Housing Crisis?
  • Recent spike in mortgage rates threatening the recent rally in U.S. housing prices
  • Strong employment data should help keep property prices buoyant for now, but the removal of job protections, or both monetary and fiscal stimulus could pose risk
They say there’s no better time to start a business than in the midst of a crisis. For Stacey Kiebler, she took that to mean that there’s no better time to buy a home than in the midst of a pandemic.
A single mother of three, Kiebler had long wanted to move from her tiny home in Flushing, Queens, New York City, to a larger apartment.
So when the pandemic hit New York, housing prices suddenly went flat and interest rates neared rock bottom, Kiebler took the plunge.
Figuring that interest rates would stay low (after all hadn’t U.S. Federal Reserve Chairman Jerome Powell promised to keep rates low till 2023?), Kiebler, like so many others, opted for a variable rate mortgage.
Then U.S. Treasury yields spiked.
What most Americans don’t realize is that what they pay on their mortgages is tied more closely to the U.S. 10-year Treasury yield than to the Fed’s interest rates – those are rates that commercial banks and other insiders get to borrow at – Treasury yields, which are derived from the marketplace, go about to set almost everything else the world gets to borrow at.
And as mortgage rates rose in each of the past three weeks, driven by a bet that inflation will accelerate as the rest of the U.S. economy roars back this year, variable rate mortgage holders like Kiebler have come under increasing stress.
Some are already wondering if the rapid spike in mortgage rates could put a cap on rallying home prices across the U.S. in recent months.
The rise in home prices caught many by surprise during the pandemic.
When lockdowns lifted, buyers like Kiebler, armed with low mortgage rates, emerged with a newfound urgency to buy bigger homes with enough room for proper home office setups and schooling via video conferencing.
Last week, the average rate for a 30-year fixed mortgage climbed over 3% for the first time since last July, according to data from mortgage lender Freddie Mac (-1.10%), up from the 2.65% all-time-low set in January.
And even small changes in borrowing costs can have a big impact for buyers who are stretching themselves thin, with a report from Redfin (+2.89%) this week calculating that an increase in mortgage rates from 2.75% to 3.25% would mean that a borrower on a US$2,500 monthly housing budget would lose some US$23,250 in purchasing power.
So is another U.S. housing crisis looming on the horizon?
The key will be employment and how that pans out.
Some analysts suggest that unemployment has more or less bottomed out in the U.S. and the vaccine rollout should provide sufficient grounds for a resurgence in business growth, and a renewed sense of optimism that could see a sharp uptick in jobs.
Job data release earlier this month suggests that could be the case as well, as better than forecast numbers were posted for U.S. employment.
And stimulus checks as well as quantitative easing has meant that mortgage markets are better prepared for any sudden shocks than they were in the past.
The key test for the U.S. housing market will be what happens when interest rates rise, and both fiscal and monetary stimulus are pulled.
It’s not likely that the U.S. is on the verge of another housing crisis, if nothing else, it’s laying the foundations for the next one. 
3. Where Has the Bitcoin Arbitrage Trade Gone?
  • Grayscale Bitcoin Trust's premium over the underlying asset it tracks was whittled away and momentarily negative as the price of Bitcoin fell last week 
  • Increasing number of alternatives and knowledge of the "Grayscale Premium" for Bitcoin indicative of a maturing market 
In Vang Vieng, a picturesque town on the banks of the Nam Xong river and nestled between rice padis and some of the most gorgeous scenery in Southeast Asia, the price of a can of Pepsi can be almost the price of a joint.
Because even though marijuana is easily available in this remote region of Laos, Pepsi is not.
Much of it has to do with logistics.
Roads in Laos have improved over the years, but many remain unpaved and impassable during the monsoon seasons.
Which has presented plucky entrepreneurs with a good arbitrage trade, buying cans of Pepsi from distributors on the cheap in cities and on boats plying the river and selling them for a handsome premium in some of the most remote villages and towns across landlocked Laos.
Tourists seldom bat an eyelid when paying these handsome premiums for their favorite soft drinks and the local arbitrageurs clean up.
And for the longest time, that was the name of a simple but highly profitable trade when dealing with Grayscale Bitcoin Trust.
For years, as the only institutional-grade gateway into the Bitcoin world, Grayscale Bitcoin Trust commanded a hefty premium over the underlying asset it was meant to track, providing a juicy arbitrage trade that hedge funds swooped in to take advantage of.
Hedge funds would borrow Bitcoin to deposit them with Grayscale Bitcoin Trust, in exchange for shares that were more valuable than the cryptocurrency they bought, and then profit by selling the marked-up shares after a compulsory six-month lock-up period expired.
Even if the price of Bitcoin fell, the premiums were often so substantial that they more than covered the fall of the underlying cryptocurrency versus the fall in the shares of Grayscale Bitcoin Trust.
The trade became so popular, assets in Grayscale Bitcoin Trust, including the rise in the value of Bitcoin, have swelled to over US$35 billion from just US$1.5 billion only a year earlier.
But that arbitrage trade is fast vanishing, thanks to more volatility in Bitcoin’s price as well as the rise of a stable of competing products.
Making matters worse, investors can’t actually redeem their shares in Grayscale Bitcoin Trust, they can only on-sell them to a fresh set of investors, which sounds sort of like another type of investment scheme made famous by a man named Ponzi.
And with the rally in Bitcoin becoming less certain, the Grayscale Bitcoin Trust premium has been rapidly falling, especially since there’s now more supply of the shares than there necessarily is demand.
Investors are choosing instead to buy Bitcoin and custody it themselves directly and last week Grayscale Bitcoin Trust shares fell as much as 11.6% below their net asset value, the biggest ever discount.
And while Bitcoin has gained almost a quarter this past month, Grayscale Bitcoin Trust is only up 14% for the same period.
Nonetheless, Grayscale Bitcoin Trust still remains an attractive offering for investors reluctant to sign up for their own cryptocurrency exchange account, or fumble with their own digital wallets.
And for institutional investors whose fund mandates prevent them from buying Bitcoin directly, Grayscale Bitcoin Trust remains one of the few access points for the cryptocurrency.
As with all arbitrage trades, the opportunities eventually get, well, arbitraged away, as more investors get wind of the opportunity.
And that’s a good thing, because it shows that the market is maturing by way of more competing products that offer the same, if not better access to Bitcoin, as well as more institutional investors potentially altering their mandates to avail themselves of more sophisticated custody options. 

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Mar 11, 2021

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